Feature

GE: Not Too Big to Grow

After more than a decade of lackluster performance, General Electric is poised to take off as it pares back financial operations and focuses on industrials. The stock could jump 30% in two years. A 3.2% yield.

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General Electricge -0.07656967840735068%General Electric Co.U.S.: NYSEUSD26.1
-0.02-0.07656967840735068%
/Date(1438376405357-0500)/
Volume (Delayed 15m)
:
22490767AFTER HOURSUSD26.09
-0.01-0.038314176245210725%
Volume (Delayed 15m)
:
706739
P/E Ratio
581.2917594654789Market Cap
262981768687.412
Dividend Yield
3.524904214559387% Rev. per Employee
468803More quote details and news »geinYour ValueYour ChangeShort position
shares have lagged behind the industrial sector and the broad stock market for more than a decade. Now, they're poised to outperform. The company in coming quarters will deliver the two things investors want most: smaller financial operations and more growth. Shares (ticker: GE), at a recent $24, could rise more than 30% over two years to $32, while paying an annual dividend yield of 3.2%.

"We have the biggest backlog of new business in the company's history," Chief Executive Jeffrey Immelt told Barron's in response to the too-big-to-grow question. "We're in industries that are growing much faster than local economies. And we have the best exposure to emerging markets of any company in the world."

General Electric CEO Jeffrey Immelt: "I'm still incredibly hungry to make the company do better."
David Paul Morris/Bloomberg

The backlog, $223 billion, is equal to more than a year and a half of GE's revenue. Last quarter, GE reported operating earnings of $3.7 billion, or 36 cents per share, down from 38 cents a year earlier. A rise in energy efficiency combined with a weak economy in Europe has led to sluggish electricity demand and double-digit profit declines in the company's power and water business, which sells turbines, generators, and other equipment. That is masking double-digit gains in other units, like oil and gas, aviation, and transportation. Six of the company's seven industrial units posted profit gains last quarter.

GE's power division is tied to key trends like the switch from coal to gas, and increased demand for wind power. As economies grow and electricity demand firms, the unit should stabilize and recover, which will make strong growth in other parts of the company more obvious, says Barclays analyst Scott Davis. GE says it can grow overall industrial revenue by 2% to 6% this year and 5% to 10% long-term, not counting acquisitions, while driving profit margins higher. This year the company is on pace to increase segment operating margins by 0.7 percentage point from last year's 15.1%, says Immelt.

Part of the margin growth will come from lower costs. The company says it can reduce selling, general and administrative costs from 17.5% of revenue last year to 16% this year and 15% next year.

GE is also transforming itself into a seller of services rather than just equipment; services now account for more than half the company's backlog. Airlines can use data from hundreds of GE sensors to reduce fuel costs and plan maintenance. Railroads can do the same to optimize trips. Software now contributes $4 billion a year to GE's revenue. And service contracts create a stream of high-margin income that can last for the life of the equipment the company sells—in some cases, three or four decades.

This year GE is expected to earn $17 billion, or $1.66 a share, on revenue of $146.3 billion. Earnings per share could rise to $2 by 2015. Shares sell for 14.5 times this year's earnings estimate. That's low for late-cycle industrials—companies that take a while to respond to economic recoveries as rising need for big capital investments gradually flows through to bookings and then profits.

Where the Money Is

A breakdown of revenue sources. Sales are expected to hit $146 billion this year.

Revenue

Contribution

Segment

2Q 2013

GE Capital

30.4%

Power & Water

15.8

Aviation

14.7

Health-care

12.4

Oil & Gas

10.9

Home & Business Solutions

5.9

Energy Management

5.5

Transportation

4.4

Source: General Electric

Siemens
(SI), for example, trades at 18.6 times earnings. A multiple of around 16 for GE would put shares at $32 in two years.

FOR THAT TO HAPPEN, GE has to look more like an industrial enterprise. One longtime knock on the company has been that GE is a bank in disguise. Financial operations once brought in more than half of profits. Management's goal is to get the contribution to 30% by 2015. It has reduced GE Capital assets from $600 billion in 2008 to $391 billion, and is aiming for $300 billion to $350 billion by the end of next year. Already it has sold commercial property and bank stakes, and Wall Street expects the company to announce by December a spinoff of its consumer-lending operations. That has been a long time coming, but with the market hitting new highs and stock offerings once again finding willing buyers, the delay could pay off.

Such a split could win fans among stock investors. There are many who like industrials and many who like consumer lenders, but few who want both in the same company. GE would retain financial businesses where it enjoys competitive advantages, like aircraft leasing, in which it uses strong industry knowledge to keep profits robust. A business like that also makes GE a major buyer of aircraft, which can't hurt demand for its engines. GE has unloaded other units, as well, including plastics and broadcasting. Other businesses, like appliances and lighting, could eventually go.

The Bottom Line

GE's earnings could grow 20%, to $2 a share, by 2015. As investors value the company more like an industrial, shares could rise to $32 from $24.

A smaller financial operation will leave GE free to invest more in manufacturing techniques and materials, like 3-D printing and ultralight ceramic composites, as well as acquisitions of suppliers. It will also provide plenty to spend on shareholders. The company says it will put $18 billion this year toward share repurchases and dividends, or over 7% of its stock-market value.

"It's been a lot of heavy lifting," says Immelt. "We're creating a high-margin industrial company with a profitable financial business, sustainable earnings growth and a ton of cash flow. I'm still incredibly hungry to make the company do better."